I know. This sounds like something that Michael Kors might be putting out. Unfortunately, golden parachute payments have nothing to do with the world of fashion – but don’t stop reading yet! This is some interesting stuff…
A golden parachute payment is an amount of money agreed upon in advance – and written into a contract – whereby a company agrees to compensate a key employee in the event of a change in ownership or control of the corporation. Basically, it’s a method of assuring a key employee (read: CEO or some other high ranking person at the company) that he or she won’t get the boot, or if he or she does, they’ll be nicely compensated. We should all be so lucky, right?
As you can imagine, these perks can be pretty nice. It can be severance pay, bonuses, options – all kinds of good stuff. And those perks are subject to the “normal” taxes (FICA, FUTA, etc.).
However, you can imagine that the IRS doesn’t love the idea of giving the company a break for all of these perks, especially when the breaks can be fairly, um, ginormous. So, under the Regs, there’s no deduction allowed to the corporation for any “excess” parachute payment.
To figure out if it’s an “excess” parachute payment, it first has to be considered a parachute payment. It is if:
- The payment is compensation.
- The payment is to, or for the benefit of, a disqualified individual. A disqualified individual is anyone who at any time within a year of change in ownership or control of the corporation was an employee or independent contractor considered to be a shareholder, an officer, or highly compensated individual.
- The payment is contingent on a change in ownership of the corporation, the effective control of the corporation, or the ownership of a substantial portion of the assets of the corporation.
- The payment has an aggregate present value of at least three times the individual’s average annual compensation over the most recent 5 taxable years.
If it’s a parachute payment under those rules, then the excess parachute payment is the amount paid out over the average compensation. In that case, the person who receives the excess parachute payment (or the “golden parachute payment”) is subject to a 20% nondeductible excise tax.
Of course, folks who are in line for these payments aren’t stupid. Or, at least, their lawyers aren’t. Generally, that excise tax is considered upfront and the amount payable is “grossed up” to make up for the tax.
As with most all other compensation, golden parachute payments are reported on federal form W-2 (or form 1099-MISC in the case of an independent contractor).
